Scale, squeeze and fees: the future of asset management

Heather Hopkins is founder and MD of NextWealth, a research business that helps firms to see what’s next in wealth. Heather has spent most of her career in financial services helping asset managers, platforms and financial advisers improve their propositions, customer communication and to benchmark success against competitors. You can hear her speak at ITAS 2018.

Historians of finance will look back on this era as the decade of disruption. Mergers abound. Regulation  puts pressure on business models and transparency. Robo-advice and passively managed funds winnow fees.

At NextWealth, we refer to these forces as “scale, squeeze and fees.” What draws them together is a unifying trend: consolidation. It’s affirmed by the recent spate of deals, including the union of Janus and Henderson, the merger of Standard Life and Aberdeen, and the acquisition of Pioneer by Amundi.

The drivers of consolidation and implications for asset managers are themes I’ll explore in my remarks at the International Transfer Agency Summit in Luxemburg on February 28th. To set the stage, consider what lies behind the consolidation: fees and squeeze (that is, pricing and regulation).

Drivers of consolidation

Pricing pressure is acute. This is in part a result of regulatory disruption. Regulators are cracking down on conflicts-of-interest inherent in commission-based distribution. They are pushing for more transparency. And the UK regulator in particular is exercised about price-clustering of actively managed funds.

Investors are also becoming more price sensitive, rapidly moving money to cheaper tracker funds and ETFs. Some active managers have responded by lowering costs of funds. In 2016, asset managers saw profits decline 2.9% while assets increased by 3%, according to McKinsey & Co. A study by Morgan Stanley and Oliver Wyman forecasts that revenue will contract a further 3% by 2019.

In this environment, mergers and acquisitions give firms the opportunity to offer a wider variety of products in a short time frame. They also allow firms to enter markets faster. For instance, Janus and Henderson’s union gives the group better access to sell Henderson funds in the US and Asia and Janus funds in Europe.

Implications of consolidation

Proliferation of ETFS

The chief consequence of consolidation will be a proliferation of ETFs. There are structural changes that favour exchange-traded funds, notably the move to fee transparency and the demise of broker commissions. Over the past 12 months, the US fund giants Fidelity, JP Morgan and Franklin Templeton all launched ETFs in Europe.

Firms looking to speed up their move into this market may look to acquire an existing provider. Backed by the resources of a larger firm, the acquired ETF business could rapidly scale. Invesco recently acquired Source, while Columbia Threadneedle and Legg Mason have also made acquisitions in this space..

Boost for boutiques

As large players battle for market share, consolidation may be a boost for boutique asset managers. There is some evidence that, with active equity funds in particular, size hinders performance. Although scale lowers back-office and marketing costs (on a per-asset basis), large funds struggle with higher trading costs and strategy dilution.

Boutique asset managers may be better positioned to differentiate themselves on performance and product. While in the past, asset managers have had to ‘pay to play’ for retail distribution, the shift to a post-commission world means that boutiques may be on a more level playing field for distribution.

Lower costs for active management

The cost of active management will decline and this will in part be driven by consolidation. One of the key motivations for consolidation is price pressure. Merged entities will need to live up to promises and reduce costs and fees. This in turn will fuel competitive pressure to reduce costs across the board.

Lower cost is also driven by the rise of passive investing. Consider that Vanguard’s S&P tracker, the 500 Index Fund, carries a management fee of just 0.14%. Asset management fees declined 6% in 2016; Morgan Stanley and Oliver Wyman believe fees will continue to tumble.

What this all means is that the asset management industry will look very different in five to ten years time than it does now. At NextWealth, we predict that a few scale players will dominate the market, while a healthy share will be divided among numerous boutique firms.

Consolidation is not the sole domain of asset managers. It’s happening across the investment supply chain too. NextWealth expects some asset managers will acquire distribution and others will join the band wagon and launch direct-to-consumer propositions.

This should be good for customers. Investors will enjoy lower prices, differentiated products and more transparency. The question now is which firms will have the capacity and courage to adapt to these disruptions -- and thrive.